The big question is whether it’s better to take a variable rate or fixed term.
Hundreds of thousands of Canadians are asking the banks for a deferral on mortgage payments while others are looking to take advantage of the Bank Of Canada’s three half point emergency rate cuts since March 4th and are asking about extending their existing mortgage or getting a new one. The big question is whether it’s better to take a variable rate or fixed term.
Before answering consider that all the pressure on mortgage rates is up. That’s why despite the fall in bond market yields, the 5 year fixed term is up. And despite the three half point emergency rate cuts and the accompanying drop in prime rate – new variable rate borrowers haven’t had the full advantage because the formula for establishing the rate has changed with the elimination of the “prime minus” provisions.
At the same time, the 5 year fixed mortgage rates haven’t reflected the full drop in the 5 year bond yields. In fact, recently 5 year fixed rates have been drifting upwards while the bond yields dropped. It’s a reminder that the Bank of Canada can lower the bank rate and the yields of 5 year and 10 year bonds can fall but that doesn’t guarantee the mortgage rates will fall accordingly. One of the big misconceptions is that banks and other lenders have to pass along the drop in the Bank of Canada’s benchmark rate. They don’t. The government cannot force anyone to lend. So even if the benchmark rate falls another ¼ or ½% it’s no guarantee that the mortgage rates will drop too.
I suspect that banks and other major lending institutions are worried that rates are going to rise, which is why they are reluctant to lower their rates further with the risk increasing.
The Big Surprise
Central banks don’t control interest rates – lenders do. The key to understand is that when interest rates rise, it won’t be because central banks start raising the bank rate. It will be because confidence in the system and the government starts to erode. As the lenders’ confidence erodes the ability of central banks to keep rates down will diminish. It’s not difficult to understand. It’s happening right now in Europe and emerging markets. In the US, the Federal Reserve is committing trillions of dollars to the credit market in an effort to maintain confidence because they know if confidence starts to diminish, the upward pressure on rates will explode as investors demand a higher risk premium.
This is the financial tug of war in our lifetimes. Can the central banks maintain confidence in the credit markets or will sovereign debt and unfunded pensions liabilities exacerbated by the economic decline caused by efforts to contain COVID19 dominate? So back to the question – should someone take out a variable rate or lock-in for 5 years – there are a great many individual factors that influence the decision but borrowers should know that all the risks point to higher rates. The bank rate is at .25% – how much lower can it go? To zero? Negative? My point is that the risk on the upside is much higher. Just like bond rates went down so dramatically in the last 6 weeks – they can go up just as fast if confidence in government erodes.
My approach is that people should know the risk they’re taking before they decide. And if they’re comfortable forecasting interest rates there are many other ways to play it besides with their home.
Source: Economic Consultant: Michael Campbell
About Michael Campbell
One of Canada`s most respected business analysts, Michael is best known as the host of Canada’s top rated syndicated business radio show MoneyTalks, and Senior Business Analyst for BCTV News on Global.
Benchmark Mortgages Inc. is an Edmonton brokerage designed to establish meaningful long-term relationships with clients and help them achieve financial freedom faster with diverse and customized mortgage options. The term “benchmark” originates from the chiseled horizontal marks that surveyors made in stone structures as an established point of reference. By definition, it is a mark that serves as a standard by which others may be judged or measured.